Collier, Accounting for Managers, 1ce

CHAPTER 4

Solutions to Problems
Problem 4.1
a.

Gross profit = Sales Cost of Sales = $100,000 $60,000 = $40,000

b.

Gross profit margin = Gross profit Sales = $40,000 $100,000 = 40%

c.

Net profit = Gross profit Expenses = $40,000 $30,000 $2,000 = $8,000

d.

Net profit margin = Net profit Sales = $8,000 $100,000 = 8%

Problem 4.2
Users of financial statements are defined by the Framework for the Preparation and
Presentation of Financial Statements as existing and potential investors, employees,
lenders, suppliers and trade creditors, customers, government and the public.
Management is not defined as a user because management has the ability to determine
the form and content of the information to meet its own needs. The reporting of
information to meet the needs of management is beyond the scope of the Framework.
Problem 4.3
Management is responsible for the preparation of financial statements in accordance
with the applicable financial reporting framework, including their fair presentation.
Management is also responsible for such internal control as it determines are necessary
to enable the preparation of financial statements that are free from material
misstatement, whether due to fraud or error.
Problem 4.4
Canadian legislation requires that organizations financial statements present fairly the
financial position, financial performance, and cash flows of an entity; be prepared
according to generally accepted accounting principles (GAAP); and be audited or
reviewed to ensure that this is the case. The principles, outlined in the CICA Handbook,
guides management in preparing financial statements that comply with this legislation.
Part I of the CICA Handbook consists of International Financial Reporting Standards
(IFRS) and is applicable to public entities. Part II of the CICA Handbook consists of
Accounting Standards for Private Enterprises (ASPE) and applies to private
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Collier, Accounting for Managers, 1ce

companies (although they can choose to use Part I if they wish). Part III applies to notfor-profit organizations. Apart from these specific issues, not-for-profit organizations
apply ASPE. There are also separate accounting standards for the public sector or
government.
These parts are often referred to as the financial reporting framework.
Problem 4.5
The purpose of the Conceptual Framework for Financial Reporting is to limit the
differences in the definitions of the elements of financial statements created by the
variety of social, economic, and legal circumstances from country to country, and by
different countries having to consider the needs of different users of financial statements
when setting national requirements. This has also resulted in the use of different criteria
for the recognition of items in the financial statements and in a preference for different
bases of measurement. The conceptual framework harmonizes regulations, accounting
standards, and procedures relating to the preparation and presentation of financial
statements. It also provides a basis for establishing an appropriate standard to use
when an accounting policy is needed.
Problem 4.6
Confirmative value: Financial information has confirmatory value if it provides
feedback about (confirms or changes) previous evaluations.
Predictive value: Financial information has predictive value if it can be used to
predict future outcomes. Financial information need not be a prediction or forecast to
have predictive value. Financial information with predictive value is employed by users
in making their own predictions.
Materiality: Information has materiality if its omission or misstatement could influence
the economic decisions of users made on the basis of financial reports .

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Collier, Accounting for Managers, 1ce

Problem 4.7
(a
)

Kazam Services--Record of Transactions

Property,
Plant &
Accounts
Equipme Receivabl
nt
e
Beginning balance
Long term loan for
building
Received from
debtors
Paid creditors
Invoiced customers
Paid salaries
Paid office expenses
Depreciation
Ending balance

(b
)

$500,000

$125,000

Longterm
Loan
$(300,0
00)

45,000
(30,000)

30,000

70,000
(15,000)
(5,000)
(20,000)
$630,000

$150,000

$70,000
40,000
$30,000

Kazam Services
Statement of Financial Position
Assets
Current assets:
Accounts receivable

$150,000

$650,0
00
20,000

Capital
$(200,0
00)

(150,00
0)
(45,000)

Service Income
Less: Expenses
Operating Profit

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Account
s
Payable
$(90,00
0)

150,000

Kazam Services
Statement of Comprehensive Income

Non-current assets:
Property, plant, &
equip.
Less: Accum.
depreciation

Cash
(Bank)
$(35,00
0)

630,000

$(40,00
0)

$(60,00
0)

$(450,0
00)

(70,000)
15,000
5,000
20,000
$(230,0
00)

Collier, Accounting for Managers, 1ce

Total assets
Liabilities
Current liabilities:
Bank overdraft
Accounts payable
Total current
liabilities
Non-current
liabilities:
Long-term loans
Total liabilities

$780,000

$40,000
60,000
$100,000

450,000
$550,000

Equity
Capital
Retained earnings
Total equity

$200,000
30,000
$230,000

Total liabilities and

equity

$780,000

Problem 4.8
(a
)

(b
)

(c
)

Working capital:
Current assets
Less: current liabilities

Total assets:
Non-current assets
Current assets

Shareholders equity:
Total assets
Less: Total liabilities ($75,000 +
$125,000)

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$125,000
75,000
$50,000

$250,000
125,000
$375,000

$375,000
200,000

Collier, Accounting for Managers, 1ce

$175,000

2013 John Wiley & Sons Canada, Ltd.

Collier, Accounting for Managers, 1ce

Problem 4.9
Answer e: Although the operating profit has increased (from $137,000 to
$139,000), the operating margin has decreased (from 11.7% to 11.1%) as a result of a
reduction in the gross margin (from 39.1% to 37%) and higher expenses (from $323,000
to $324,000), despite sales growth (of 6.4%).

Sales
Less: Cost of goods sold
Gross margin
Less: Selling & admin expenses

2012
$1,250,000
787,000
463,000
324,000
$139,000

2011
$1,175,000
715,000
37.0%
460,000 39.1%
323,000
11.1% $137,000 11.7%

Problem 4.10
a. Prepayment
The annual payment is 24 $400 = $9,600 (this is $800/month). The prepayment at
March 31 is 9/12 (AprDec) @ $800 = $7,200.

Profit is reduced by $2,400 (expense: 3 months @ $800).

Asset in the statement of financial position is increased by $7,200

(prepayment is an asset: 9 months @ $800).

Cash flow is reduced by $9,600 (payment December 31).

NB: The effect of the prepayment of $7,200 is to carry forward the expense to the
next financial year.
b. Accrual
The simple solution is to divide $6,000 by 12 months and charge $500/month to profit.
However, this ignores seasonal fluctuations and cash flow differences from quarter to
quarter.
The quarterly bills have been paid during the year, but the last quarterly bill was in
November. Therefore the business is missing one months expense (that is, December).
To determine the amount we need to calculate the seasonal charges:

$6,000 70% = $4,200 for SeptemberFebruary / 6 months = $700/month.

$6,000 30% = $1,800 for MarchAugust / 6 months = $300/month.

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Collier, Accounting for Managers, 1ce

Accrue for one month (December) = $700.

Profit reduced by $700 (expense). This is the profit adjustment. In total,

expenses are $6,000 for the year.

Statement of financial position shareholders equity (capital) is reduced by

$700 and liabilities are increased by $700 (accrual is a creditor).

Cash flow has no impact (no money yet paid).

NB: The effect of the accrual is to reduce by $700 the expense impact of the
expected bill for three months of $2,100, which will be received in February. This
leaves $1,400 as the expense ($700 for each of January and February).
c. Depreciation
Depreciation is 20% of $12,000 = $2,400 p.a. or $200/month. As depreciation is
charged from the next month, it needs to be provided for the period JulyMarch. For
that period, depreciation is $200 9 = $1,800.

Profit reduced by $1,800 (depreciation expense).

Statement of financial position assets (PP&E) increased by $12,000 (new

asset) and reduced by $1,800 (accumulated depreciation), leaving a net value
of $10,200.

Cash flow reduced by $12,000 (payment for new system).

NB: The statement of financial position value of the asset will be reduced by $2,400
per annum until the asset is written down to a nil value, sold or disposed of.
Problem 4.11

a
.

Rent invoice:

Inc
Dec

Statement of
Comprehensive
Income
Rent
2 mo.
Exp.
Rent
2 mo.
Profit
Rent

Dec
Inc
Dec

b
.

Purchase
machine:

Inc
Dec

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Dep.
Exp.
Profit

$2,000
$2,000

* Dec
Inc
Inc

Statement of Financial
Position
2 mo.
Equity (RE)
Rent
4 mo.
Prepaids
Rent
6 mo.
Cash
Rent

Equity (RE)
Fixed assets
Accumulated

$2,000
$28,000
$2,000

Collier, Accounting for Managers, 1ce

Dec

Dep
Cash

$28,000

*($28,000 - $4,000) / (6 x
12) x 6 months
c
.

Bad debts:

Inc

Expense
s

$22,000

Dec
Profit
$22,000
* through increase to contra account: Allowance
for Doubtful Accounts

Dec
Dec

Equity (RE)
Acc.
Receivable*

$22,000
$22,000

Problem 4.12
Rosi Inc.
Statement of Comprehensive Income
for the month ended January 31, 2012
Sales
Less: Cost of goods sold
Gross profit
Less:
Admin salaries
Commission
Depreciation
Rent & Utilities
Operating profit before
interest and taxes
Less: interest
Profit before taxes
Less: Income tax expense
Profit after taxes

$200,000
134,000
66,000
$5,000
2,100
2,500
3,100

$12,700
$53,300
800
52,500
12,000
$40,500

Problem 4.13
It would be disclosed as a loss. Expenses arise only from ordinary operations. A sale
of an asset is not considered to be a cost associated from generating operations
income.
Problem 4.14

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Collier, Accounting for Managers, 1ce

It will be recorded as a gain. Revenue arises in the ordinary course of business (for
example sales, fees, interest, etc.). Gains represent other items such as income from
the disposal of non-current assets or revaluations of investments.

2013 John Wiley & Sons Canada, Ltd.

Collier, Accounting for Managers, 1ce

Problem 4.15
Current carrying value of
asset:
01-Jul09 Purchase of machine
Less: Accumulated
depreciation
31-Dec12 Carrying value
Gain on sale:
Selling price
Carrying value

The sale will be accounted for

as follows:
Fixed Assets--Equipment
Equipment-Accumulated
Depreciation
Income: Gain on sale of
asset

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$50,000
31,500

($50,000 - $5,000)/5 years x

3.5 years)

$18,500

$25,000
18,500
$6,500

$50,000

Decrease

31,500

Decrease

18,500

Increase